Valuation clause important part of shareholders' agreement

By Kirsten McMahon, AdvocateDaily.com Managing Editor

A shareholders' agreement that doesn’t contain a valuation clause could create uncertainty and even animosity among parties if an evaluation of shares is required later on, Toronto business lawyer Anton Katz tells AdvocateDaily.com.

Katz, principal of Anton M. Katz Barrister & Solicitor, says there are a variety of circumstances where a corporation’s shares would need to be evaluated and sold, including death, disability, bankruptcy, marital breakdown, or retirement of a shareholder.

“In determining the value of the shares to be sold, there are three different types of reports,” he says. “The one that provides the most assurance is a comprehensive valuation report, followed by an estimate valuation report, while the least assuring is a calculation valuation report.”

Katz says these reports are prepared by chartered business valuators who are acting independently to determine the value of shares of the corporation. Depending on the circumstance for which the valuation is being prepared, a detailed report might not be required.

“In those cases, it would be acceptable to provide a calculation valuation report,” he says. “However, in other situations, where more detail is required, a comprehensive valuation report is what would be most appropriate.”

As a practical example, Katz says if a corporation wanted to figure out the value of certain assets for tax planning purposes, it might not need the most comprehensive report.

“Let’s say you own real estate, you would tell the valuator what the property is valued at, and they plug that number in without doing any other checks,” he says.

“If your corporation is involved in a transaction between two people — they’re not necessarily related, but it’s a friendly deal — you may just need a report that’s verified but doesn’t require a high level of detail,” Katz says.

In that example, the valuator may appraise and verify the asset, but wouldn’t add in any extra information about trends or historical financial information.

“The most comprehensive level would be a report more appropriate for court, for example, where parties might be relying on that information, particularly in a contentious situation,” he says.

Katz notes the purpose of a shareholders' agreement is to plan out in advance what actions will be taken in certain circumstances. If things become contentious, an agreement can help avoid arguments about what to do later on.

“However, if you have a shareholders' agreement that doesn’t specify what type of valuation will be conducted, the parties could end up in court,” he says.

Because each type of report requires a different amount of skill, time and money, clients should understand the different levels of assurance so they can decide in advance what they are most comfortable with, Katz says.

“By having a lawyer draft a shareholders' agreement, we can review the relationship of the shareholders as well as the different situations that may arise that would require a valuation,” he adds.